Real Estate Forum Magazine - July/August 2009 edition
Midway through the first year of his term, President Barack Obama and his administration have wrestled with a hydra of problems. But the government’s numerous interventions and political wrangling has received mixed reviews at best, particularly within the commercial real estate community.
Much of the dissatisfaction has stemmed from the ever-changing terms of initiatives to restore liquidity. Take, for example, the Federal Reserve’s extension of the Term Asset-Backed Securities Loan Facility to the CMBS market. Back in May, the Fed announced that, as it had done in the consumer debt markets, it would offer inexpensive, non-recourse financing to investors to purchase commercial securities. At the time, only newly issued, AAA-rated loans with three-year maturities were eligible. Shortly after, the maturity was expanded to five years. By the end of the month the rules were once again modified to include legacy CMBS, high-quality debt issued before 2009.
“You have a government putting out very mixed signals,” says Philip F. Blumberg, chairman and CEO of Blumberg Capital Partners in Coral Gables, FL. “So you have to imagine that the market is all over the place.” The constant change in course, he says, has had a dramatic effect on the intraday rates for CMBS and has not instilled a compensating confidence in the debt class. Blumberg, like many in the industry, suggests the constant tweaks to the commercial portion of TALF reflect the government’s rudimentary understanding of the market.
Nevertheless, there is anticipation that the availability of financing through the program will trigger new securitization and loosen the constraints on credit. Restoring liquidity to the market is especially pressing in light of mushrooming loan delinquencies and defaults. the overall rate of missed or late loan payments penciled in at almost 3% as of the end of May, compared to 0.56% for the same period a year prior, according to Trepp. And Real Estate Econometrics pinned the national default rate for commercial mortgages at 2.25% in the first quarter, up 1.62% from Q4 2008. Assuming defaults continue on a steady trajectory with limited issuance, Fitch Ratings predicts the rate will exceed 5% by year’s end.
Dire forecasts are endless. At least two-thirds of the $410 billion in loans maturing within the next nine years is unlikely to qualify for refinancing because substantial value depreciation has left them with negative equity, according to a recent Deutsche Bank report. But the rest of debt coming due, the report indicates, would succeed in obtaining refinancing as credit is restored. For now that path seems littered with roadblocks, thrown up almost regularly.
A case in point: Standard & Poor’s proposed changes to its rating methodology. To quality for TALF, securities must have at least a AAA rating from S&P, Fitch Ratings, DBRS, Moody’s Investors Services or Realpoint. but S&P’s actions would result in a widespread downgrades of top-rated CMBS, cutting the amount of eligible commercial loans in half.
Even before this latest development, the TALF extension could be considered a toss of dental floss to a drowning man. To be clear, the program excludes floating-rate mortgages, construction loans or debt secured by assets without consistent cash flow. As a result, some observers have concluded that the program will play a marginal role in flushing toxic debt from the market.
Yet others in the industry argue that it is too soon to disparage the extension, especially since the full breadth of it won’t get under way until July. Speaking to GlobeSt.com, Michael Goldsmith, head of the commercial real estate practice group at BBK, said, “The Fed’s decision to open TALF to CMBS legacy loans is a wise on because it effectively primes the pump.” He concluded, “It will also establish a benchmark price for AAA securities. then we will have a much better understanding of what these securities are worth.”
Advocates of the extension also point to the effect it has had on the consumer side of the debt market. “TALF has been somewhat successful in restarting securitization in that part of the economy and it has brought spreads down in that area,” says Jeffrey D. DeBoer, president and CEO of the Real Estate Roundtable in Washington, DC. “So assuming that is a model for how TALF might work for commercial real estate, I would say it’s a good start.”
At the Securities Industry and Financial Markets Association and Pension Real Estate Association’s June summit in New York City, William C. Dudley, president and CEO of the Federal Reserve Bank of New York, noted, “Spreads on consumer ABS Have been coming down sharply from the peak levels reached late last year. For example, the spreads of AAA-rated credit card ABS have narrowed from a peak of about 600 basis points over Libor to slightly above 200 basis points currently.”
Robert Knakal, chairman and founder of New York City-based Massey Knakal, contends that the consumer side of TALF has done very little to reinvigorate the credit markets because of the disconnect between the conception of the program and its implementation. Pointing to the debt disposition aspect of the plan, he notes the Federal Deposit Insurance Corp. had set out to move some $100 billion in toxic debt out of the system. But to date, there have only been a handful of transactions, netting roughly $3.2 billion.
“The attractiveness of these programs has been less than was anticipated because of the attitude the administration has had toward the people who they hope to be participants,” says Knakal. He argues that such government actions as eliminating bonuses, capping executive pay and calling investors “greedy speculators” have crated a contentious relationship.
“On one hand, the government kicks sand in investors’ faces and then later asks them to come back to the sandbox and play.” And while participants in TALF or the Public-Private Investment Program stand to make hefty profits, Knakal says, they may be vilified for doing so. “I’m sure some funds are going to take the risk and invest, but certainly you are not going to have the type of participation that you might have otherwise, which would have led to more activity, more volume, more competition and a healthier dynamic.”
For an investor like Blumberg, a firm statement that the government is focused on the asset, not the entity receiving the financing, would help him feel confident about partaking in TALF or PPIP, as would a halt to further changes, he says. “These kind of statements would drive the CMBS market into an improved situation with regard to pricing and we wouldn’t be guessing what’s going to happen tomorrow,” he says.
But there are other factors that may yet steer the government’s efforts off course, namely the counterintuitive move to relax mark-to-market rules. the Financial Accounting Standards Board’s decision will certainly provided banks greater flexibility in calculating the value of assets and likely reduce write-offs. But in doing so, it may also curb the enthusiasm for aggressive trades of toxic assets through such programs as PPIP.
“On the one hand, healthier banks and financial institutions are a net positive for the market,” explained Gary Gabriel, executive director of Cushman & Wakefield’s metropolitan area capital markets group in East Rutherford, NJ, to GlobeSt.com. “the flip side, however, is they won’t be forced to sell. This move forestalls clearing these assets off of banks’ books.”
Even those who were once strong proponents of easing the rules, such as RER, are reconsidering their stance on the matter. “A year and a half ago, I felt very strongly that the mark-to-market rules were in effect pro-cyclical. If the trend was going down, it would help continue and accelerate it,” says DeBoer. “At this point in time, relaxing the rules might in fact be counterproductive to what we all want to see happen in the PPIP program on legacy loans and asses.”
While Thomas Bisacquino, president of the Herndon, VA-based National Association of Industrial and Office Properties, understands these concerns, he maintains, “The mark-to-market rules have created an unrealistic depiction of what assets are worth. In essence, it’s not forcing the lenders to carry those assets at zero value. So I do think the modifications will help.”
Bu the fear of lenders holding on to their distressed assets is strong nonetheless and it’s being further fueled by the FDIC’s decision in June to suspend distressed sales through the Legacy Loan Program. “Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor-confident in our banking system,” said FDIC chairman Sheila C. Bair in a statement announcing the postponement.
Positive results from the banking stress tests have further validated this position. Some observers credit the transparency of the financial institutions with improving investor confidence, helping to rally the stock market in the past few months.
Blumberg contends, however, that there is a false sense of economic prosperity within the banking sector, which is only going to drag out a recovery. “We know that leverage is the enemy of this economy. So we need write-downs. by reversing course on these programs, you are telling capital sources, ‘Don’t rely on anything we say’,” he states.
To be clear, Blumberg has long held the view that the government has had too much of a hands-on approach to the economic crisis. He maintains that for the long terms, it would be better to allows poorly run companies to go under. “I’m not suggesting government needs to sit on its hands, but it has played too strong of a role in the private sector,” he maintains.
Keywords: AAA, Barack Obama, BBK, CMBS, commercial real estate, credit, DBRS, Federal Reserve Bank, Financial Accounting Standards Board, Fitch Ratings, Jeffrey D. DeBoer, loan, Massey Knakal, Michael Goldsmith, Moody's Investors Services, Philip F. Blumberg, Policy, Public-Private Investment Program, Real Estate Roundtable, Realpoint, Robert Knakal, S&P, TALF, Term Asset-Backed Securities Loan Facility, toxic debt, William C. Dudley
